There are many excellent trading strategies out there, and purchasing books or courses can save you time finding ones that work. Many traders spend hundreds or even thousands of dollars looking for a great trading strategy, but trading can also be a "do it yourself" career. Building your own can be fun, easy, and surprisingly quick.
To create a strategy, you'll need access to charts that reflect the time frame to be traded, an inquisitive and objective mind, and a pad of paper to jot down your ideas. Then you formalize these ideas into a strategy and "visually backtest" them on other charts. In this article, we go over the process from start to finish and offer important questions to ask along the way.
- Creating your own trading strategy can save time and money while also being fun and easy.
- The first step into creating your own trading strategy is to determine what type of trader you are, your time frame of trading, and what products you will trade.
- When creating a trading strategy, it is best to see how an asset performed in the past by looking at historical data.
- Creating entry and exit points along with other rules can help a strategy be successful.
- Testing a strategy on a variety of indicators and different time periods helps determine how and when the strategy will perform and the best ways to earn a profit and avoid losses.
- Do not try and rely on strategies that work 100% of the time as that is impossible.
Time and Place
Before a strategy can be created, you need to narrow the chart options. Are you a day trader, swing trader, or investor? Will you trade on a one-minute time frame or a monthly time frame? Be sure to choose a time frame that suits your needs.
As an example, let's say you choose to look for stocks on a one-minute time frame for day-trading purposes and want to focus on stocks that move within a range. You can run a stock screener for stocks that are currently trading within a range and meet other requirements such as minimum volume and pricing criteria.
Stocks, of course, move over time, so run new screens when needed to find stocks that match your criteria for trading once former stocks are no longer trading in a way that aligns with your strategy.
Creating and Testing Strategies
Creating a strategy that works makes it much easier to stick to your trading plan because the strategy is your work (as opposed to someone else's). For example, suppose that a day trader decides to look at stocks on a five-minute time frame. They have a stock selected from the list of stocks produced by the stock screen they ran for certain criteria. On this five-minute chart, they'll look for money-making opportunities.
The trader will look at rises and falls in price to see if anything precipitated those movements. Indicators such as time of day, candlestick patterns, chart patterns, mini-cycles, volume, and other patterns are all evaluated. Once a potential strategy is found, it pays to go back and see if the same thing occurred for other movements on the chart. Could a profit have been made over the last day, week, or month using this method? If you are trading on a five-minute time frame, continue to only look at five-minute time frames, but look back in time and at other stocks that have similar criteria to see if it would have worked there as well.
After you determine a set of rules that would have allowed you to enter the market to make a profit, look to those same examples and see what your risk would have been. Determine what your stops will need to be on future trades to capture profit without being stopped out. Analyze price movement after entry and see where on your charts a stop should be placed. When you analyze the movements, look for profitable exit points. Where was the ideal exit point, and what indicator or method could be used to capture most of this movement?
When looking at exits, use indicators, candlestick patterns, chart patterns, percentage retracements, trailing stops, Fibonacci levels, or other tactics to help capture profits from the opportunities you see.
Depending on how often you want to look for strategies, you can look for tactics that work over concise periods of time. Often, short-term anomalies occur that allow you to extract consistent profits. These strategies may not last longer than several days, but they can also likely be used again in the future.
Keep track of all the strategies you use in a journal and incorporate them into a trading plan. When conditions turn unfavorable for a certain strategy, you can avoid it. When conditions favor a strategy, you can capitalize on it in the market.
You do not need to look for strategies that work 100% of the time. In fact, if you do, you'll likely find no workable strategies.
Additional Trading Tips to Consider
Using historical data and finding a strategy that works will not guarantee profits in any market. It is for this reason that many traders do not backtest their strategies, which is applying the strategy on historical data. Instead, they tend to make spontaneous trades. This is a lack of due diligence. It's important to know a strategy's success rate because if a strategy never worked, it is unlikely to start working today suddenly. That's why visual backtesting—scanning over charts and applying new methods to the data you have on your selected time frame—is crucial.
Many strategies don't last forever. They fall in and out of profitability, and that's why one should take full advantage of the ones that still work. If something has worked for the past few months or over the course of the past several decades, it will probably work tomorrow. But if you never looked to the past to test that strategy, you might not even realize it was there, or you might lack the confidence to apply it in the markets tomorrow to make money. Knowing that something has worked in the past will thus also give a psychological boost to your trading.
Trading needs to be done with confidence (not arrogance), and being able to pull the trigger on a position when there is a set-up to make money will require the confidence that comes from looking to the past and knowing that, more often than not, this strategy worked.
Keep in mind you do not need to look for strategies that work 100% of the time. In fact, if you do, you'll likely find no workable strategies. Look for strategies that net a profit at the end of the day, week, or year(s), depending on your time frame.
Backtesting is a crucial element of any strategy that allows a trader to see how a trade worked in the past and will most likely in the future.
The Bottom Line
Strategies fall in and out of favor over different time frames; occasionally, changes will need to be made to accommodate the current market and your personal situation. Create your own strategy or use someone else's and test it on a time frame that suits your preference.
By looking back, you can give yourself some great starting points to make more money and avoid losses as you become more experienced. Track all strategies that you use so that you can use these strategies again when conditions favor it.